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Problem: Alex Cook, owner of the Yum Yum Pretzel Company, bought a pretzel twister, nicknamed the "Alpha," 5 years ago for $300,000. The Alpha manufactures 400,000 pretzels per year, and the pretzels currently sell for 40 cents each (suppose that the variable cost to produce a pretzel is zero). The Alpha is anticipated to last forever, with the annual maintenance expense of $30,000. Mr. Cook is considering purchasing a new machine, the "Beta." The Beta costs $500,000 and will also last forever, with a yearly maintenance expense of $20,000. The Beta can manufacture 600,000 pretzels per year, which would as well sell for 40 cents each. Mr. Cook figures that he could sell the Alpha today for $40,000. Pretzel twisters are depreciated on a straight-line basis to a zero salvage value over 5 years. The firm pays taxes at a rate of 40%, and employs a discount rate of 10% for project analysis.

i) Create a timeline or table of the relevant cash flows, and evaluate the NPV of Mr. Cook's replacement decision.

Financial Accounting, Accounting

  • Category:- Financial Accounting
  • Reference No.:- M93705

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